An empirical examination of stock markets growth in the emerging economies (1980--2000)

The rapid expansion of the emerging stock markets over the last two decades has motivated academic research to raise important questions about their impact on the macroeconomic performance. Although the role of stock markets in economic growth has recently gained some academic attention, the expansion of emerging stock markets has not. This study tries to explain the stock market growth in the emerging economies over the last two decades. The focus of the study is two-fold; first, examining the empirical relationship between stock market development and economic growth, while controlling for the impacts of the financial liberalization and privatization policies, foreign portfolio investment, and political risk, and second, detecting the direction of this relation.;To explore the first issue, the study uses a data set for 40 countries over the 1980--2000 period with Two Stage-Least Squares approach which was complemented by the Fixed Effect technique. The findings showed that stock market growth was mainly driven by economic growth. It was also shown that financial liberalization and foreign investors participation have positively affected emerging stock markets. To examine the second issue, based on the availability of data, monthly data on 12 emerging economies over the 1988--2000 period was utilized. Results based on Johansen cointegration test suggest an existence of long-term relationship between both of stock market size and liquidity and real economic activity. In addition, the results of Granger causality test---modified by Toda-Yamamoto---reveals an existence of bi-directional relationship dominates the link between market size and liquidity on one hand and economic growth on the other hand with some space left for a uni-directional link going from real economic activity to stock market.;The results are consistent with Rossell's model (1991) who argues that economic growth is a key factor in stock market growth. In addition, the results fit with the demand-following proposition introduced by Patrick (1966) who argues that the growth of an economy leads to a growing demand for loans and other financial services. Furthermore, the findings suggest an important role of the government policies in activating the stock market. One of the main policy implications that follow from this study is that governments in the emerging economies can help promote financial sector-stock market development through further liberalization measures.